04 October 2023
Global inflation has peaked and the price of raw materials is stabilising once again – but the cost of manufactured equipment remains stubbornly high.
Linesight’s Martin Breheny (Regional Director, Project Management) considers reasons for this imbalance, and strategies for mitigating the risks to construction projects.
It has been a challenging few years for the construction industry, with strong fluctuations in materials costs challenging the viability of projects. The COVID-19 pandemic has caused severe disruption to global supply chains, exacerbated by the Russia-Ukraine conflict and the resulting spikes in energy and commodity prices. Thankfully, after hitting 8.75% in 2022 – the steepest annual increase since 1996 – global inflation seems to have peaked. In 2023, it is predicted to fall back to 7.0%, and to 4.7% in 2024. However, while commodities are stabilising, inflation in the price of manufactured equipment remains high, and significantly out of step with input costs.
Linesight’s latest global commodity report for Q2 2023 shows inflation in key materials softening, with copper and steel prices on a downwards trajectory. This can be partly attributed to reduced demand from Chinese manufacturers, and the easing of supply chain disruption as logistics return to normal. At the same time, factory gate prices for equipment such as air-handling units, generators, pumps, clean room systems, fan coil units and water treatment systems are not falling. For construction clients in the mission-critical sectors, this presents an ongoing risk that must be managed.
To understand what elevated equipment prices may mean for projects in the short and medium term, it is helpful to look more closely at the causes.
One of the most significant is the cost of shipping. Between 2019 and 2023, container freight rates oscillated dramatically as e-commerce soared, and the pandemic created huge demand for products while disrupting global supply chains. The impacts of a shortage of shipping containers and a spike in prices are still being felt today. Energy and commodity shocks are quickly reflected in consumer price inflation, but fluctuations in shipping costs are felt over a much longer period. An IMF study found that while the inflationary impact of global oil prices peaks after two months, the effects of shipping costs only peak after about a year and can last up to 18 months. Equipment prices received in Q4 2022 and Q1 2023 may still have been within the 18-month period after what the IMF calls the “cargo crunch” at the start of 2022.
There are a number of other contributing factors that are combining to keep inflation high. The IMF predicted that reduced shipping costs should flow through to reduced prices at the factory gate this year, but this has not happened yet. This is partly because demand for equipment is far outstripping supply, with highly serviced sectors, such as data centres and high-tech manufacturing facilities for semiconductors and batteries, all experiencing strong growth. At the same time, the capacity of the supply chain to take on new orders is strained as manufacturers continue to clear the backlog of preorders from customers who sought to protect themselves against future rises. Confidence may be a factor too: capacity reduced during the pandemic, and some manufacturers have been slow to ramp back up again in the face of market volatility.
There is always a time lag before lower input costs are reflected in prices, particularly as manufacturers may still be locked into hedging arrangements that they entered into in 2021/22 – products emerging at the factory gate today may be the product of inflated energy and materials costs from up to 18 months earlier. Similarly, global supply chains are still suffering the lagging effects of bottlenecks caused by COVID-19, cargo blockages and the war in Ukraine. In particular, border restrictions due to the pandemic were still in place throughout Asia until autumn 2022, and in China until January 2023, and constraints in the availability of raw materials are still causing price spikes for certain inputs. High labour costs and currency fluctuations will also contribute.
While we wait for the market to stabilise, there are several actionable steps that construction clients can take now to protect themselves. We may not have control over the many forces at work in global supply chains – but by being proactive, there is much we can do to mitigate the risks.